It’s not North Korea that’s the worry

The unexpected death of a tyrant in the country that sits next to the primary driver of global commodity demand could be a classic Black Swan type event – the sort of event that can suddenly send markets plummeting.

This is what happened yesterday when North Korean dictator
Kim Jong-il
died suddenly. Now his inexperienced son Kim Jong-un will attempt to work with the military to ensure stability in this impoverished country.

The North Koreans have launched a short range ballistic missile – just a warning to tell everyone to stay away.

But a threat from outside is unlikely, and given the isolation of the North Korean people and the cruelty of the regime, a threat from inside right now is unlikely. There is the possibility of a power struggle within the military, but that too is more likely to simply lead to greater hardship for the North Korean people rather than regional instability.

This at least is how the markets currently view the North Korean situation. Equity markets had a short-term negative reaction in Asia yesterday but they steadied up in Europe last night, before falling in the US. The decline in the US though was not because of Kim Jong-il’s death. It was because of concerns that the European debt crisis in the new year will spin out of control.

Commodities were also steady.

No, North Korea is unlikely to rock commodity markets.

But there is another possible Black Swan type event underway in Wukan in southern China’s Guangdong Province.

Related Quotes

Company Profile

The villagers of Wukan, near Hong Kong, could create much greater havoc for resource markets if their current mini-revolution gets wider traction.

After all, China is the only real source of end-user demand for resources left standing.

The fishing village of more than 10,000 residents is in open revolt. Protests began three months ago when villagers claimed that the local government grabbed land from the people and sold this on to a developer.

Anger escalated this month after a villager, Xue Jinbo, died in police custody.

The Communist Party is nowhere to be seen in this now isolated village. The village is surrounded by thousands of police and the party leaders have scampered, but the villagers have set up their own administration and guard the village perimeter awaiting a crackdown.

The local authorities say they will halt the land project at the heart of this dispute.

But in Wukan all trust has been lost, and many people say they will continue to make a stand, reported the BBC.

The conflict in Wukan is just one of thousands of such conflicts over land transfers in China. The number of protests, riots and strikes doubled in five years to almost 500 a day last year, according to Sun Liping, a professor at Beijing’s Tsinghua University.

Beijing has taken a surprising hands-off approach to the conflict and the internet and other forms of communication remain alive. No-one is sure why.

Some believe Beijing may use this as a way to attacking corruption and introducing greater political reforms.

Others think Beijing may be waiting for Christmas when the foreign journalists in Wukan leave. They will then crack-down.

On balance though, Wukan is unlikely to set a wider revolution alight.

Anecdotally, most Chinese seem happy to trade some freedom for a better life and most Chinese believe a strong one-party system is needed to control a diverse nation of 1.3 billion people. Few want to revert to the bedlam of the Cultural Revolution or the pre-1949 warlord era.

But Beijing better keep feeding the people cake.

An economic slowdown is underway in China.

China’s economic growth is contracting from more than 10 per cent, the average of the past decade, to around 8 per cent next quarter.

This is not enough to trigger dissent, but if by chance the economy begins to contract uncontrollably because of market forces, then political instability will likely escalate.

No-one expects this to occur but if it did, it would be a Black Swan event that would completely obliterate commodity markets.

This is particularly so because of the economic mess that Europe, Japan and the US are all in. The legacies of the great recession of 2008 are much deeper and more dangerous than almost everyone predicted.

One sign that self-propelled market forces can inflict damage on the Chinese economy is currently the sharp decline for the second month in a row in November in the amount of foreign exchange purchased by China’s central bank.

This points to continued capital outflows.

Barclays Capital China economist Jian Chang estimates the outflows, using a broad definition including outward foreign direct investment, portfolio outflows and hot money outflows, were around $US30 billion in November and October, compared with an inflow of $US15 billion in September.

And then there’s US economist Paul Krugman worrying that China is now like Japan at the end of the 1980s or the US in 2007.

He fears that China’s recent growth has relied on a huge construction boom fuelled by surging real estate prices – that China is exhibiting all the classic signs of a bubble.

Most China-based economists remain positive about China. There remains massive pent-up demand for all sorts of things, from houses to cars and refrigerators, and the infrastructure build is not nearly complete.

China has the surpluses to restimulate the economy and the policy-space to do so now that inflation is easing.

China is no Black Swan yet either.

But then, by definition, a Black Swan event is one that none of us can predict.